Finance

How protectionism risks undermining the US economy

Jonathan Haskel — Tue, 25 Feb 2025 10:39:25 +0000

How protectionism risks undermining the US economy

Jonathan Haskel Tue, 25/02/2025 - 10:39

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Donald Trump’s announcement of wide-ranging tariffs has threatened to upend the rules of global trade that have been in place for decades, impacting supply chains and businesses across the world.

The US President’s plan has been designed, in his words, to be reciprocal. What could be fairer than this? The theory is that the US will charge its trading partners in response to what they charge them.

What this means in practice is that the US will charge a country based on it having a goods trade surplus with the US. Some countries that do not have a notable surplus will still be hit with a universal baseline tariff of 10 per cent. For example, countries in the European Union will be subject to a 20 per cent tariff, while the UK will face the baseline 10 per cent tariff.

As the consequences of these tariffs will have major consequences for the global economy, it is worth considering the logic that has informed this decision and whether it stands up to scrutiny from an economic perspective.

Let’s say a country, for example the UK, is running a goods trade deficit with Costa Rica of £100 worth for bananas. From an economics point of view such a deficit makes perfect sense: the UK does not grow very good bananas, but we are good at education and financial services, which we export by accepting Costa Rican students, and providing secure banking for Costa Rican residents. Therefore, we run a deficit on goods, balanced by a surplus on services.

President Trump's reciprocal tariff calculation asks: what would the British tariff have to be on Costa Rican bananas to rebalance trade in bananas? He appears to have done this by assuming the tariff would raise an import price by a certain percentage, which in turn would cause British consumers to switch away from imported bananas by another percentage, which would then reduce banana imports. Select those percentages and work out the tariff that would entirely wipe out all imports. Then take half of that number (for obscure reasons) and that is the alleged tariff rate which Costa Rica is charging the UK.

These bizarre counterfactual calculations have nothing to do with the actual tariffs which are imposed. True, our bananas trade is likely affected by tariffs and safety standards on agricultural products. But fundamentally the pattern of trade is determined by the patterns of comparative advantage across different countries. To repeat, if the UK is good at financial services and education and Costa Rica is better at bananas, both are better off with free trade.

What then follows from this?

Firstly, these numbers should not be taken as an estimate of the type of tariffs which the US or any other country faces. Average tariff rates which the UK imposes on the US are well below five per cent when calculated properly - that is, zero per cent on the vast majority of goods, and higher percentages on goods like agricultural products.

We should also not assume that the UK has been given special treatment by having a lower rate than other countries. The US has a slightly lower trade deficit with the UK than with Europe, so the simple maths of this calculation would lead to a smaller ‘reciprocal’ tariff.

Thirdly, we should remember that the US is a relatively closed economy. British imports are around 30 per cent of GDP, American imports are around 15 per cent, so we must not overstate the impact of unilateral American restrictions on trade on the world.

Unless we descend into a full trade war, the economy most hurt by these measures is the American economy.

The right response to these tariffs is to carry on trading and let the US sink under the weight of its own bad policies.

More narrowly, what does this mean for the UK? The effects of this policy will of course be concentrated in certain export sectors, such as the car industry, and I would expect policies to be forthcoming to mitigate that adverse shock. But more broadly, we should stay focused on what will get the UK economy growing: policy to encourage science, clusters and startups.

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